Will Syria Burst the Turkish Bubble?

Ten years ago this month, a political earthquake swept Turkey. The Justice and Development Party, an Islamist-oriented group better known by its Turkish acronym AKP, took 34 percent of the vote in parliamentary elections but, because of a quirk in Turkish election law, won 66 percent of the seats. The AKP's victory marked the first time any Turkish party wielded an absolute parliamentary majority since 1983 when Turgut Özal's Motherland Party took just over half of the seats. While an Islamist party held the premiership for a year in the 1990s, never had an Islamist government wielded such a substantial parliamentary block.

Turks voted for Recep Tayyip Erdoğan's party not because they agreed with his religious and sectarian agenda, however, but rather because he promised to put the economy first. The Turkish public blamed squabbling and often corrupt incumbents for the banking and currency crises which hit Turkey in quick succession at the beginning of the millennium. In one day alone before the elections, the Turkish lira lost one-third of its value, a significant hit to income and quality of life.

The AKP was true to its word. Not only did the government stabilize the Turkish currency but, less than two years after Erdoğan took the reins of government, it knocked six zeros off the Turkish Lira. While this move had more cosmetic than fiscal value, it was psychologically important for a country in which hyperinflation was for so long the norm.

The Turkish economy took off. From 2002 through 2005, Turkey's real GDP growth rate ranged between 6 and 8 percent, before stabilizing at the 4 percent rate for the next two years. The European debt crisis and global recession led to a sharp decline into 2009, but Turkey's economy proved resilient; for the last two years, growth has exceeded 8 percent, putting it only behind China in terms of modern, non-oil based economies.

A Fragile Economy

Turkey's success rests on tenuous underpinnings, however. Erdoğan financed Turkey's growth by accruing vast amounts of debt; in the first five years of his increasingly autocratic rule, he has saddled Turkey with more debt than all his predecessors combined since the foundation of the Turkish Republic in 1923. Debt is not a problem unless, of course, slowed growth or recession prevents Turkey from meeting its obligations. Unfortunately for Erdoğan, it appears Turkey is heading into a perfect storm.

In September, Turkey's Central Bank Governor Erdem Başçı suggested the government would miss its growth target of 4 percent. In January, inflation topped 10 percent for the first time in years, and while it has since fallen back to 7.8 percent, that is still nearly twice the rate of early 2011. The problem is not just government debt: David Goldman, who served as global head of debt research at Bank of America between 2002 and 2005, found that since late 2009, Turkish banks have lost $20 billion of foreign assets while they accrued $50 billion of foreign debt. The result is that bank liabilities now outpace assets by more than 300 percent.

Demand Is Falling

While Turkish exports have increased multifold in the last decade, recession and instability in Turkey's overseas markets will undercut Turkish business. The European Union debt crisis and unfavorable exchange rates have adversely affected Turkish business. On August 1, 2012, Economy Minister Zafer Çağlayan announced that Turkey's automotive exports had declined 22.3 percent in June 2012, when compared to June 2011. Shrinking demand in Europe also led to a 12 percent decline in sales of Turkish-made clothes.

Meanwhile, domestic demand is also plummeting. The Turkish government predicted demand growth at 4.1 percent, but demand has actually shrunk. Add into this personal debt. Household debt has increased 36-fold since the AKP took power. Because interest rates are so high—over 18 percent—many Turks borrow simply to pay interest without making a dent in principal. With the economy beginning to contract, the stability of the Turkish bubble is increasingly tenuous.

"There is no soft landing in the economy," Faik Öztrak, the vice chairman of the opposition Republican Peoples Party (CHP), observed.

The Syria Question

Against this backdrop, the Syrian crisis could not come at a worse time for Turkey. According to the Turkish Foreign Ministry, Turkey's trade has increased from $773 million in 2002 to $2.27 billion in 2010; the ministry predicted that figure would more than double within two years. Instead, Turkey and Syria are exchanging fire at their border and trade has plummeted to near zero, on top of which, Turkey must now house and care for tens of thousands of Syrian refugees.

Reverberations from the Syria conflict will ripple through Turkey. While the Turks claim that tourism has not suffered, Turkish economists suspect the government manipulates tourism statistics in order to cover debt; the statistics are based on relatively unscientific polls at sea and airports. Certainly, precedent matters. Ankara claimed that they lost up to $30 billion as a result of the 1990-91 Iraq War and no-fly zone operations; the Syrian conflict could become just as costly.

The ripples of war have already eroded Turkey's hopes of winning the 2020 Summer Olympics, which Erdoğan saw as a symbolic celebration of Turkey's first-world status. He may wine and dine the International Olympic Committee, but no amount of hospitality will overcome anxiety about regional war, refugees, and even chemical weapons.

Whereas Erdoğan sought to make Turkey one of the world's top ten economies, his chief rival Kemal Kılıçdaroğlu now suggests it could fall out of the top 20. If Syria bursts the Turkish bubble, even that estimate may be optimistic.